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Need a down payment?
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December 28, 2000: 6:08 a.m. ET
Siren call of early IRA withdrawal may tempt, but try to resist, experts say
By Staff Writer Jeanne Sahadi
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NEW YORK (CNNfn) - There's nothing like a down payment to freeze-dry your desire to become a first-time home owner. If you're still marking time in your salad days or have begun to raise a family, putting down 10 percent or 20 percent on a house can seem about as realistic as buying a little castle on Capri.
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Generally we don't like it because there's no way to pay it back.
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Barry Picker
CFP, CPA |
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If you have a traditional or rollover IRA, however, there is a provision that may tempt you: First-time home buyers may withdraw up to $10,000 penalty-free. But you will pay income tax on that withdrawal. And if you take out any more, you will be charged not only income tax but a 10 percent penalty on the amount above the $10,000 limit.
Most financial planners caution their clients to use this provision only as a last resort.
"Generally we don't like it because there's no way to pay it back," said Barry Picker, a certified financial planner and certified public accountant in Brooklyn, N.Y. That is, you will still be limited to the $2,000 federal limit on annual contributions. Consequently, you won't be able to rebuild your account quickly, and you will lose the benefits of compounding on a large lump sum.
What about my 401(k) or Roth?
Given the choice, CFP Andy Keeler of Columbus, Ohio, would rather his clients take a loan against their 401(k)s because they will be expected to pay it back in full with interest, although they must do so with after-tax dollars. A 401(k) does not allow for penalty-free early withdrawals for first-time home purchases.
A Roth IRA has the most flexible provision: you may withdraw any of your own after-tax contributions at any time as a first-time home buyer plus you may withdraw up to $10,000 in earnings, presuming the account has been open five years and you've already taken out all your contributions. But again, you're undoing the good work you've done saving for retirement, experts say.
Premature use of retirement funds can really hurt down the line. Among clients who dip into their long-term savings, "I know full well they're going to get into their 50s and 60s and they'll have deep regret," said CFP Russell Hall of Wichita, Kan.
So what's a renter to do?
The goal is to contribute to your tax-deferred plans first and tap them last, Picker said.
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 CONSIDER OTHER RESOURCES BEFORE YOUR IRA
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Budget
Family
Taxable investments
Emergency fund
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But that doesn't mean you have to forfeit the right to complain about your mortgage at cocktail parties.
Before siphoning money from an IRA or 401(k), consider your other resources.
Start with your budget, Keeler said. If you're just getting cozy with the idea of owning a fireplace, chances are good a year or two may pass before you actually settle on a house. Use that time to save for a down payment. "It's very common for people to have a surplus that's going into a black hole," Keeler said.
If possible, borrow from family, Picker suggested. Or, if you have taxable investments, consider selling them, he added.
And if you're one of those people who have built up a lot of cash "just in case," now's the time to use it. You might treat your IRA as a true emergency fund in the interim until you can build your cash surplus back up, Picker said. Beware though: you will pay income tax and a 10 percent penalty should you actually need the IRA money for an emergency.
Another option Picker suggested is to figure out the bare minimum you need to put down on a home and take out a bigger mortgage. The advantage to doing so over, say, taking out a 401(k) loan is that your mortgage payments, while larger than you might like, are tax-deductible, whereas the interest you pay on your 401(k) loan is not.
Don't forget closing costs
Remember, too, it's not just a down payment you're saving for but closing costs as well.
As a rough rule of thumb, assume that your closing costs will equal about 5 percent of your home's purchase price, but since such costs are somewhat negotiable they may be higher or lower, according to a spokesman for the National Association of Realtors.
One way to compensate for IRA withdrawal
If you're really pressed and an IRA withdrawal is your only out, there may be a way to curb the downside of lost compounding.
First, Keeler said, try to buy a home in an area where housing prices are appreciating so that you have a better chance of turning a profit when you sell it. But also try to find a home that costs you less to live in, after taxes, than if you were paying rent, then invest that after-tax difference in the market.
"It all boils down to discipline and what you do with the savings," Keeler said. 
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